• Sat. Jul 24th, 2021

What’s the Best Way to Pay Yourself: PAYE or Dividends by Neil Debenham

Neil Debenham

As a company director, working out how to pay yourself is one of the most significant decisions you’ll make. It can have consequences not only for your business, but also for the total amount of tax you’ll need to pay as an individual.

If you’ve just started operating a business and need to pay yourself for the first time, it’s best to talk to an accountant about your options. However, you can also learn a lot on your own, letting you make an informed decision when you’re ready.

Below, Business Adviser and Corporate Consultant, Neil Debenham shares some valuable information on dividends versus a PAYE salary for company directors preparing to pay themselves.

What is PAYE?

PAYE, or Pay As You Earn, is a tax system that allows you to pay your income tax and national insurance contributions. Instead of paying your taxes in a lump sum, your tax and contributions are deducted from your wages or salary as you’re paid by your employer.

For example, an employee hired by a company may receive their wages every two weeks, with income tax and national insurance contributions deducted from the amount and sent to HMRC by their employer.

PAYE offers certain advantages. The first is that it’s a simple method of paying income tax and national insurance contributions. Every time you pay yourself from your business, you’ll need to calculate the amount of tax and national insurance contributions as liabilities for HMRC.

The second is that a small amount of your salary will be exempt from tax. Currently, the tax-free Personal Allowance is £12,500 per year.

If you haven’t already set up PAYE for your business, you can do so by reaching out to HMRC as an employer. The process is straightforward, simple and essential if you pay yourself or any other employees via this process.

Despite its advantages, a PAYE salary has significant downsides. The first is that the rate of tax and national insurance can be quite significant, particularly if you’re paid a high salary from your business.

Currently, the top income tax rate is 45 per cent, which is applied to annual income of £150,000 or more. Below this amount, income of £50,001 to £150,000 is taxed at 40 per cent and income of £12,501 to £50,000 is taxed at 20 per cent.

What are dividends?

Dividends are payments that are made from a company to its shareholders. A dividend is a share of the profit the company makes. The company directors are responsible for choosing whether to pay a dividend and, if so, how much to pay.

As a company director, paying yourself via dividends offers a range of financial advantages. The first is that dividends are taxed differently from PAYE income, with dividends generally taxed at a lower percentage rate if you have a high income.

Currently, the basic rate for dividends (covering income of £12,501 to £50,000 and equivalent to 20 percent tax on income) is 7.5 per cent. The higher rate (covering income from £50-£150,000 and equivalent to 40 percent income tax) is 32.5 per cent.

Finally, the additional tax rate on dividends (for income of £150,000 or higher and equivalent to the 45 per cent income tax) is 38.1 per cent. In the UK, a company does not need to pay tax on its dividend payments — instead, the shareholders will be liable. The company will, of course, be liable for corporation tax..

The government also provides a £2,000 annual allowance for dividends, on which you won’t be required to pay any tax. You can find more information about this and tax rates for dividends on the UK government’s website.

In conclusion

As with many questions related to taxes and accounting, there’s no one-size-fits-all answer. In some cases, the simplicity of the PAYE system may be the best option for you as a company director. In others, the lower rates may make dividends the better choice, concludes Neil Debenham.

If you’ve recently started a company and need to pay yourself for the very first time, your best option is to talk to an accounting specialist. Working together, you’ll be able to pay yourself in the most efficient way from both a business and taxation perspective.

Neil Debenham www.neildebenham.com

Neil Debenham

Neil Debenham is a seasoned entrepreneur with a string of successful business ventures to his name. He specialises in the financial services sector

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